Here’s why bond yields are rising around the world

www.marketwatch.com

A global bond-market selloff sent yields around the world jumping in the past week, reflecting the potential for a pickup in inflation as well as growing suspicions that major central banks may be less aggressive about boosting monetary stimulus.

The 10-year Treasury yield TMUBMUSD10Y, +0.00%  rose nearly 11 basis points this week to end Friday at 1.847% — the highest close since May 27. The yield is up more than 24 basis points so far in October, but remains around 43 basis points below where it started the year. Yields increase as debt prices fall.

The yield on the 10-year British government bond, or gilt TMBMKGB-10Y, +0.00% this week hit its highest level since the June Brexit vote. The yield on the German 10-year bond TMBMKDE-10Y, +0.00% known as the bund, which was negative as recently as early October, also jumped to its highest level since May.

Rising yields weighed on stocks, with the S&P 500 SPX, -0.31%  logging a four-day losing streak. Some yield-sensitive sectors, such as real estate and telecoms, underperformed.

The selloff comes after a big rally, which took the U.S. yield to an all-time low in July. While the 10-year Treasury yield could test the 2% level, many analysts expect such a move would prompt renewed buying interest.

That said, what’s behind the recent weakness? Here’s a quick guide.

Monetary stimulus pullback

After nearly eight years of extraordinary measures, including numerous rounds of quantitative easing and forays into negative interest-rate policy, there is growing consensus that major central banks are running out of room on the monetary stimulus front.

The Federal Reserve is headed toward its second rate increase after tightening last December. Meanwhile, a will-they-or-won’t-they debate centers on whether the European Central Bank will soon move toward tapering its bond purchases; the Bank of England appears reluctant to provide additional easing and its chief, Mark Carney, questions the efficacy of negative interest rates.

Indeed, a stronger-than-expected reading on third-quarter U.K. gross domestic product helped trigger Thursday’s selloff. The data further curbed prospects for additional stimulus by the Bank of England.

At the Bank of Japan, the desire is to steepen the yield curve, raising questions about its willingness to press the accelerator any further. Remarks by BOJ Gov. Haruhiko Kuroda that appeared to reiterate that desire also helped spark selling Thursday, analysts said.

Overall, those factors have combined to lift yields, particularly at the long end.

Typically, a predisposition of monetary tightening would be seen as a relative negative for longer-dated yields. But a primary goal of the central bank’s extraordinary stimulus efforts has been to drive down long-term yields and flatten the yield curve — the differential between short- and longer-dated maturities.

So a pullback in stimulus would be expected to steepen the curve and lift long-term rates, at least relative to shorter-dated bonds.

On top of that, there are growing expectations for fiscal stimulus, which would also be a negative for bonds as governments increase debt, though analysts caution that investors may be getting ahead of themselves.

Inflation expectations

Despite a potential slowing of monetary stimulus, inflation expectations are on the rise. And that is also cited as a reason for rising yields.

Inflation eats away at bond returns. Investors see central bankers, who have been battling the threat of deflation, as eager to tolerate inflationary pressures.

Analysts at Danske Bank argued in an Oct. 27 note that a rise in commodity prices will lift global inflation in the near term, particularly as the drag from the past oil price decline fades. That will help reduce the “deflation scare,” while leading the market to price in greater inflation prospects.

They argue, however, that central banks — which have tried in vain to lift inflation expectations — would welcome that development. And that means that instead of scaling back stimulus significantly, they would be likely to maintain an accommodative stance.

That still means bond yields have further room to rise, since loose policy in the face of rising inflation would further lift inflation expectations. But the Danske analysts don’t expect a prolonged bear market for bonds, arguing that the commodity-inspired inflation lift should prove temporary.